Political change, the stimulus that India needs

India’s growth pains are a symptom of the structural – economic, social and political – malaise that the country has sunk into, in the last decade.

Raghuram Rajan, the Chief Economic Advisor to the Government of India, has written a piece recently on why growth in India slowed and how it could be revived. He blames the growth slowdown in India on the failure of India’s institutions to cope with the high growth rates experienced during 2002-2007 and on the global financial crisis. Further, he blames political opposition to investment projects that slowed capital formation.

All explanations have an element of truth in them. The above is no exception. But they minimise the importance of dysfunctional and cynical governance that has brought about India’s current economic mess: high inflation, high fiscal deficit, low growth and high current account deficit.  What India is experiencing is not a ‘garden variety’ cyclical slowdown caused by inventory accumulation or a mild pick-up in inflation; India’s growth slowdown is structural. Yes, the proximate cause is a rapid decline in capital formation. However, faith in the government and the Rule of Law has receded to such an extent that risk-taking in the real economy has all but vanished. Trust between counterparties is essential for commerce to flourish. Contracts help but without trust that they would be honoured, they are largely worthless. If all contracts are settled in courts, the judicial system would be overwhelmed. Trust has been the single-most important factor underpinning economic activity in all economic systems, whether capitalist or socialist.


The trust that the Government of India is an honest interlocutor, a ‘disinterested’ party, that it would create and maintain a level playing field for all participants has taken such a big knock that nothing short of political change can begin to restore that trust. Only then can animal spirits revive. The scandals that this government has created and the sums involved have been unprecedented in the history of independent India. We briefly examine those and assess the mood of the country.

We also draw up on research from Forensic Asia (an independent bottom-up research company that analyses corporate balance-sheets) to argue that a more immediate obstacle to revival of investment spending is that the corporate sector is maxed out. The long and painful process of de-leveraging has just begun as the corporate sector accumulated too much debt in the boom years and now is payback time.

Unless India’s intellectuals and elites can agree that this government has caused tremendous harm to the idea of India and that, at the minimum, political change is required to reverse India’s fortunes, India’s recovery will remain elusive.

A partial list of corruption and other scandals since 2004

Coalgate –This refers to the disputed allocation of coal mines (a public asset) that cost billions to the exchequer and to bidders with no experience in coal mining. Their intent was to trade the license for a profit!  This ‘Coalgate’ has spawned many sub-gates. The Prime Minister was personally in charge of the Coal Ministry from 2006 until 2008 because the UPA had a fugitive from law as its cabinet minister in charge of the Coal Ministry. The PM had to take over the Ministry when he ‘disappeared’. The investigative agency, charged by the Supreme Court to report to it directly, has submitted its report to the Law Ministry for ‘approval’ ahead of placing it before the Court.

Spectrum Gate – This refers to the allocation of spectrum (airwaves) to bidders in the telecommunications industry, again in a controversial manner that cost the exchequer billions in licensing fees. In order to deflect attention, the government appointed a Joint Parliamentary Committee (JPC). The word, ‘Joint’ suggests a committee comprising of Members of Parliament from the ruling and opposition parties. The government nominee who headed the JPC never invited the Opposition members for a meeting. He refused to allow the former Minister for Telecommunications to testify since the former Minister had said that the Prime Minister was fully in the know of all the decisions  he took.

CWG Gate – This refers to the corruption scandals around the Commonwealth Games in New Delhi in 2010.

Environment Gate – This refers to the withholding of environmental clearances for many projects.

Vadra Gate – This refers to the various land deals that the son-in-law of Ms Sonia Gandhi engaged in. He had perfect foresight, buying land in various places ahead of the announcement of industrial projects there. An upright officer of the Indian Administrative Service, who questioned some of the deals, has been transferred more than once and the Government of the state of Haryana is questioning him for his actions in cancelling some of the transactions.

Something changed for the worse in India in 2004

Most economists – not just in India – completely exclude the social and political environment in their analyses. They do so for two reasons. One is that it is hard to include social and political variables in a quantitative model of the economy. Two, they have been stable for the most part in Western democracies. Hence they ceased to be a factor influencing short-run (one to two years) economic (mis) fortunes.

Unsurprisingly, Indian economists have followed the lead set by the West, at the expense of losing touch with reality in India. Politics has always been a big factor and the change in government in 2004 was a big event for India’s economic progress.  The Congress-led United Progressive Alliance (UPA) was a post-poll alliance. Moreover, it was determined to repudiate the Bharatiya Janata Party (BJP)’s ‘India Shining’ campaign. In hindsight, the BJP slogan might have been a bit early but it was positive and aspirational. The Congress-led UPA, on the other hand, had no idea of how to govern a semi-liberalised modern economy with a young and aspiring population. Its slogans, politics, ideas and policies were excavated from the 1970s, despite them not having delivered the goods even then. The extra-constitutional/unconstitutional National Advisory Council was populated with ideologues and hangers-on who were only too keen to endorse Sonia Gandhi’s ill-informed and unproductive and unsustainable fiscal populism. They refused (and still refuse) to acknowledge that their prescriptions for eliminating poverty have been discredited empirically.

The upshot of all of these was a change in emphasis from growth to redistribution through fiscal hand-outs. Many bravely chose to ignore it by focusing on personalities who were reformers in an earlier era but the control of the government had passed into the hands of Sonia Gandhi who had no inclination for or understanding of the importance of economic growth to achieve her pet equity outcomes. It has turned out that the reformers did not have strong convictions to stand up to her brand of economics. Redistribution orchestrated by the government resulted in concentration of discretionary power in the central government. Abuse and aggrandisement inevitably follow concentration of power. Further, the obsession to stay in office meant tolerating and even collaborating with corruption engaged in by various coalition partners in their respective ministries.

For a while, the failure to recognise this important change did not appear to matter due to the global nature of the economic boom that lasted up to 2007. India too prospered or appeared to. Now, analysts and the Indian economy stand exposed. Complacency and a hubristic belief in the inevitability of India’s rise have brought things to such a pass now that big question marks linger over India’s political and economic future.

‘Institutional failure’ sounds dignified but misleading

It is a good sign that economists look beyond business cycle models and acknowledge the importance of institutions. That is what Raghuram Rajan has done in his recent piece cited earlier. In his words,

To revive growth in the short run, India must improve supply, which means shifting from consumption to investment. And it must do so by creating new, transparent institutions and processes, which would limit adverse political reaction. Over the medium term, it must take an axe to the thicket of unwieldy regulations that make businesses so dependent on an agile and cooperative bureaucracy.

One example of a new institution is the Cabinet Committee on Investment, which has been created to facilitate the completion of large projects. By bringing together the key ministers, the committee has coordinated and accelerated decision-making, and has already approved tens of billions of dollars in spending in its first few meetings.

However, the Cabinet Committee on Investment (CCI) is not an example of a good institution. For institutions to gain legitimacy and credibility, it takes time and trust in the leadership of that institution. The CCI, being an institution of the UPA government led by a man whose ‘reputation is in tatters’, is unlikely to be an effective one. There is no guarantee that decisions of the CCI will be respected by his own Cabinet members without dissent. In any event, as Ila Patnaik explains, escalation in costs since the time these proposals were submitted for approval until now and the difficulty in obtaining funding might render the CCI approvals academic.

Corporate de-leveraging has a way to go

The large and organised corporate sector is in a soup of its own making for it had taken on more debt in the good days expecting them to last forever. Now, it is payback time. The table below, from Forensic Asia (‘Asian Financial Stress: the North-South divide widens’, 25 April 2013), shows that the debt/operating cash-flow ratio is too high – higher than the danger mark of 6.0 in several sectors (Figure 1).  Excepting for companies in communications, technology and consumer non-cyclical sectors, others have no scope to increase capital expenditure. Further, the fact that the corporate sector has just started to experience cash outflows also militates against any immediate resumption of investment spending on their part (Figure 2).

 Figure 1: Debt/OPCF (x) by Market and Sector: 2012 – too much corporate debt in India


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(Source: Forensic Asia. 1-In China only 743 out of 1,200 companies have full data and in the Philippines just 39 out of 174)

Figure 2: Free Cashflow/Profit: Indian corporates experiencing free cash outflows


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(Source: Forensic Asia. * March 2012 Financial year-end. ** Incomplete data, implied number)

Political change must precede institutional overhaul

In any event, the rest of the country has long abandoned any faith in this government to look after the national interest. Therefore, investment intentions are missing. Kumar Mangalam Birla of the Aditya Birla Group said so in his Bloomberg interview a month ago. He would rather invest outside India. The trust factor has to be restored. Governments do not always have to support economies with big investment projects. Acts of leadership in pursuit of national interest would do the trick, even if actual results, in terms of economic growth, take time to show. Leadership and trust stimulus are more effective in restoring economic dynamism and animal spirits than fiscal stimulus.


Recently, some fond hopes have been expressed that the drop in the prices of crude oil and gold augurs well for India’s current account deficit to decline and economic growth to revive. Not only do input costs become lower, but also the room for rate cuts by the Reserve Bank of India is expanded. Forecasts of pick-up in growth in the second half are gaining currency. We caution against premature optimism.

India’s growth pains are but a symptom of the structural – economic, social and political – malaise that the country has sunk into, in the last decade. It would need leadership of the kind that Britain and the United States were blessed with in the 1980s to revive India’s economic fortunes. The arrival of such leadership would signal a bottom in India’s financial assets even if underlying corporate fundamentals take time to improve. Unfortunately, we are a long way from there as the elections are not due until May 2014 and the outcome is too hazy for any confident predictions to be made.

Photo: Meena Kadri